On the Efficiency of Competitive Equilibria with Pandemics

Abstract: The epidemiological literature suggests that virus transmission occurs only when individuals are in relatively close contact. We show that if society can control the extent to which economic agents are exposed to the virus and agents can commit to contracts, virus externalities are local, and competitive equilibria are efficient. The Second Welfare Theorem also holds. These results still apply when infection status is imperfectly observed and when agents are privately informed about their infection status. If society cannot control virus exposure, then virus externalities are global and competitive equilibria are inefficient, but the policy implications are very different from those in the literature. Economic activity in this version of our model can be inefficiently low, in contrast to the conventional wisdom that viruses create global externalities and result in inefficiently high economic activity. If agents cannot commit, competitive equilibria are inefficient because of a novel pecuniary externality.

Keywords: Lockdowns; Virus exposure; Local public goods;

JEL Classification: H41; E60; D62;

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Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Staff Report

Publication Date: 2023-04-05

Number: 644